The banking industry is paying up for the housing crisis. This is what you need to know.


(Emmanuel Dunand/Agence France Presse via Getty Images)

Citigroup reached a $7 billion civil settlement with the Justice Department on Monday for selling investors securities stuffed with toxic mortgages. It's the latest in a string of government deals rooted in the housing-bubble-era misdeeds. Indeed, it seems there's at least one of these housing settlements announced every other week. So what's this one about? And how is it similar or different from all the others?

For the answers to these and other head-scratching questions, here is a settlement cheat sheet.

What's a mortgage security?

Big banks like Citigroup and JPMorgan Chase take multiple home loans made to people like you and me, then bundle them into bonds for sale to investors. When homeowners pay their mortgages, a portion is distributed to investors who purchased the security that holds the loan.

Selling these "mortgage securities" was big business in the years before the 2008 financial crisis. The returns were so attractive that government-sponsored mortgage finance twins Fannie Mae and Freddie Mac snagged some of the bonds, as did countless pension funds, charities and municipalities.

So what's the problem with these securities?

As demand for mortgage securities grew, banks relaxed the lending standards for home loans to the point where anyone with a pulse could get a loan. People, in some cases, received mortgages without any proof of their income or were placed in high-cost loans, even when they demonstrated no ability to repay the debt. This meant that the securities were packaged with loans that were destined to fail if the borrowers couldn't make the monthly payments. And that is exactly what happened once the economy went south.

Investors were aware that some of the securities they purchased were made up of subprime loans — mortgages made to people with poor credit or small down payments — that carried higher risks. But the government says many banks that issued the securities failed to tell investors just how bad some of the mortgages were.

How is any of this related to the financial crisis?

Depending on whom you ask, mortgage securities were at the heart of the crisis. The billions of dollars of losses on mortgage securities freaked out the markets. It triggered a loss of confidence in the nation's financial system that reverberated around the world.

Losses on the mortgage securities were so severe that it shut down lending, prompted a $700 billion bailout of the nation's banking system and led to the $188 billion bailout of Fannie Mae and Freddie Mac.

What's Citigroup's role in all of this?

Citigroup, like JPMorgan and Bank of America, issued, structured and underwrote a whole lot of mortgage securities in the frothy days of the housing market.

By one estimate, the bank packaged and sold $91 billion worth of the securities in question from 2004 to 2008. That's a fraction of what its competitors sold — Bank of America, including its Merrill Lynch unit, sold $965 billion, while JPMorgan, including its Bear Stearns unit, traded $450 billion. But the government said Citigroup issued securities with a higher percentage of bad loans compared with others and was well aware of how awful the mortgages were.

In an internal e-mail uncovered by the Justice Department, a trader at Citigroup advised that colleagues "should start praying" because he "would not be surprised if half of these loans went down." He said he feared that there were "a lot of loans that have unreasonable incomes, value below the original appraisals," and found it "amazing that some of these loans were closed at all."

How does this settlement differ from all the other housing settlements that you keep writing about.... I mean, I feel like there is one every week?

This deal has to do with mortgage securities, whereas some of the others — National Mortgage Settlement and Independent Foreclosure Review — arose from allegations that lenders used forged and shoddy paperwork to quickly foreclose on struggling homeowners, a practice known as “robo-signing.”

The foreclosure settlements are directly tied to the way banks treated people struggling to hang on to their homes, while the securities settlements are about the way banks misled investors who purchased their securities.

Justice scored a $13 billion settlement with JPMorgan in November over its sale of shoddy securities, but there have been a slew of other securities cases brought by the Securities and Exchange Commission and the Federal Housing Finance Agency. Indeed, FHFA filed suit against 17 banks to recoup losses from the nearly $200 billion in mortgage-backed securities sold to Fannie Mae and Freddie Mac.

In other cases, banks, including Wells Fargo, have paid out money to resolve allegations of steering black and Latino borrowers into high-cost home loans and charging excessive fees.

Okay, but why does Citigroup have to pay $7 billion? Why not $8 billion or $12 billion?

Citigroup certainly argued that it shouldn't have to pay much of anything considering that it had a smaller share of the securities business than Bank of America or JPMorgan. That argument didn't fly with prosecutors, who said there was ample evidence that the bank knew it was selling junk, and a lot of it.

"The market-share argument does not trump the evidence of the case, it does not trump the conduct of an institution," Associate Attorney General Tony West said at a news conference Monday. "These resolutions will always be driven by the conduct, the evidence and the facts of the case."

And in the case of Citigroup, West insists there was more than enough evidence of misconduct in the 25 million documents that the Justice Department reviewed to warrant a $4 billion civil penalty, the largest the department has imposed on a firm.

Where is all of this money going?

In addition to the $4 billion penalty, $500 million will go to the Federal Deposit Insurance Corp. and states attorneys general (Massachusetts, California, Delaware, New York and Illinois) who were separately investigating the bank for piss-poor securitization practices that hurt state pension funds.

The remaining $2.5 billion is supposed to be doled out in various forms of consumer relief — reductions of the principal balance on home loans, lower interest rates, down payment assistance and affordable rental housing. This last part of the agreement has left some folks questioning why consumers are being helped when it was investors who were harmed.

In last year's $13 billion settlement with JPMorgan over mortgage securities, Justice said the structure of that deal, which included help to struggling homeowners, would be the template for others. The department has said banks should have to help communities that were most affected by the economic devastation they caused.

So who's going to jail?

No one ... at least for now. Attorney General Eric Holder said at the news conference that prosecutors went as far as the evidence would allow, but that does not preclude the possibility of the Justice Department bringing criminal charges down the road.

Is this the last big settlement?

Not by a long shot. West and Holder made it pretty clear that they are looking at several other banks that engaged in similar behavior. Justice has asked Bank of America to cough up $12 billion for its part in the securities debacle, but negotiations are at an impasse over the terms of the deal. Analysts also suspect that Goldman Sachs is one of the several banks in the settlement pipeline...stay tuned.

 

Danielle Douglas covers the banking industry for The Washington Post.
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